Even with the gains in the stock market over the past week or two, we are still down considerably from the October 2007 peak and basically flat for many companies over the past decade plus.  This, coupled with the sagging economy and irrational pessimism towards the stock market, has caused some to claim that buy and hold is dead as an investment strategy.  I want to remind everyone of a common flaw in comparing recent performance to historical returns.

As John Bogle reminded us late last year, roughly half of the commonly touted 10% historical return of the stock market is comprised of dividend income.  You might look back on the last 10 years and say that we’re under-performing historical returns by 10% per annum, but when dividends are considered we’re not nearly that bad.

Consider the case of General Electric, a favorite among large-cap dividend investors.  GE has recently been trading around $10 a share.  It last traded around a split-adjusted price of $10 in September of 1995.  So you might conclude that an investment in GE for the last 13.5 years earned you a big fat 0% per annum.  Considering dividends changes that conclusion entirely.  Each share you bought for $10 in September of 1995 would have paid you $9.92 in dividends through the years.  So the total value of your $10 investment would be $19.92, or a gain of 99.2%.  Annualized over 13.5 years, that’s a gain of about 5.25% per year.  What first seemed to be no gain over the past 13.5 years is only 4.75% per year under the historical expectation.  Still not great, but much better than zero.  Those calculations assume that you pocket the dividends throughout the years.  If instead you had reinvested them, your initial $10 investment would be worth $14.22 for a gain of 42.2%, or about 2.6% per year.  Reinvesting would have netted larger gains as recently as 6 months ago and only appears worse now because of the rapid decline in GE since that time.  (Six months ago the annualized gains just from dividends for GE would have been 5.45% and 7.23%, without and with reinvestment respectively.)

One problem with many portfolios is that they hope to achieve historical returns (or better) but contain few dividend producing stocks.  The lights out performance of many sectors may be worth giving up dividends when times are good, but seems like a much worse idea when times are bad.  I’m not saying that you should only own stocks that pay dividends.  I own some that do and others that don’t.  Just remember when you’re comparing performance to historical returns that dividends make a significant contribution.

For more in-depth coverage of dividend investing than I could ever hope to provide, check out all the great content The Dividend Guy has to offer.